CHINA: Encouraging outlook for long-term growth

Analysis

Debate about the true rate of GDP growth (see CHINA: Growth figures may be consistently exaggerated - OADB, May 28, 2002, III. ) glosses over what is at the root of China's economic expansion, and how sustainable it is. Economic growth is still something of a mystery to economists. Theories advanced in the 1960s explained growth as a function of the accumulation of key 'factors' -- capital, labour and technology. Later theorists added 'human capital' -- skills, training and education. Other economists have identified trade as a causal factor. The 1993 World Bank 'Asian Miracle' report used a crude measure of an economy's openness to trade as the key variable in explaining the rise of East Asian economies. Recent work has cast doubt on that study's methodology, and some academics, including Dani Rodrick, have shown that trade has no role to play in growth -- although this is a contentious finding.

Tiger critique . Although a coherent model of growth remains out of reach, components of growth are well established. An economy can grow, at least over a short period, simply as a result of the addition of more resources, ie factors. Alwyn Young ex-ante showed this to be the case of the four Asian tigers (South Korea, Taiwan, Singapore and Hong Kong): far from being a 'miracle' explained by openness to trade or special strategies of government intervention, their growth can almost entirely be explained by high rates of investment, transfer of labour from agriculture to manufacturing and higher labour participation rates. Young predicted the problem for Asia was that total factor productivity (TFP) growth was at a comparable level to the rates of OECD economies. TFP is the efficiency of the use of inputs; the more efficiently one uses inputs, the faster the economy grows. Over the long term, productivity growth is required to sustain economic growth. This suggested that since productivity growth in Asia was normal, the region's abnormal rates of growth were unsustainable over the long-term.

Exuberant sentiment of much foreign investment in China recalls the optimism of pre-Asia crisis sentiment in the Asian tigers. This in turn raises the TFP question, since concentrations of capital and labour are important in explaining China's recent growth. It absorbed one-third of all foreign direct investment (FDI) in the developing world in the last decade, and has the world's second-highest savings rate. Labour too is abundant, leading to an average monthly factory wage of only 100 dollars.

TFP trouble . Measurements of TFP growth in China are contentious. Data are frequently unreliable, internally inconsistent or not available over sufficient durations. The choice of deflators for output, materials and investment goods; changes in employment practice; and gradual adoption of international accounting standards make comparing statistics in different periods difficult. However, a number of attempts have been applied to the economy as a whole and to particular sectors:

Macroeconomy .A World Bank study broke down the annual 10.2% growth rate during 1985-94 into three parts: 6.6% from factor accumulation; 1.1% from labour reallocation; and 2.5% from TFP growth. Wang Xiaolu, a Beijing University professor, is more optimistic. Examining 1979-98, he estimates that capital, labour and human capital contributed to two-thirds of the average 9.7% growth rate in GDP, with TFP gains making up 3.2% of growth. Wing Thye Woo of the University of California finds that during 1985-93 net TFP growth actually fell. He explains growth as the sole result of factor accumulation and says reallocation of labour after the Cultural Revolution and the shift to a market-based economy accounted for 45-100% of GDP growth.

Sector-specific .Gary Jefferson, Thomas Rawski, Wang Li and Zheng Yuxin have found a broad rise in TFP during the reform period, although TFP growth decelerated, and actually fell, for state-owned enterprises (SOEs) and shareholding firms (largely restructured SOEs), during 1992-96. TFP for other types of firms, including collective firms (local government-owned firms run for profit) and private firms, rose. Baiding Hu and Michael McAleer, looking at different sectors during the 1990s, found that TFP growth occurred in agriculture, transport and telecommunications sectors, but that all growth in industry, construction and services was completely reliant on increased investment. In certain periods, TFP growth actually declined.

Surveying the findings, there appears to be little evidence that TFP is growing at a significant rate above the average 2-3% of OECD countries. Indeed, some evidence suggests that certain sectors and firm types are experiencing negative TFP growth. This is consistent with the wealth destruction of loss-making SOEs. It suggests growth in excess of OECD norms will be maintained only as long as factors are increased at high rates, after which growth will slow to the level of TFP growth. Exactly when this will happen is difficult to predict. FDI is currently on an upward trend, and -- barring financial crisis or political instability -- there are few visible barriers to it. Moreover, China's urban population is relatively small compared to other Asian economies. Roughly a third of the population resides in the cities, in comparison to 39% in Indonesia, 57% in Malaysia, 59% in Taiwan and 85% in South Korea. There is still much scope for labour allocation to more productive parts of the economy.

Outlook . China is growing from a low base. Significant economic distortions in the economy provide scope for efficiency gains and thus TFP growth. Much depends on government policy. SOEs and shareholding firms are major drags on efficiency; their privatisation will improve management incentives and spur efficiency gains. Resolution of persistent inter-provincial barriers to commerce would correct significant distortions in allocations of labour, capital and human talent. Barriers to labour mobility are indeed falling, with the dismantlement of the decades-old household registration system. Better financial intermediation would improve the productivity of China's huge capital resources (see CHINA: Bad debt resolution offers opportunities and risks - OADB, October 4, 2002, IV. ). Under WTO membership, further exposure to international competition will motivate efficiency gains, while more FDI in high-end manufacturing will accelerate access to technology and better management practices.

While the similarity in foreign exuberance regarding pre-crisis Asia and today's China is concerning, two aspects of the 'tiger' comparison may actually be cause for optimism:

Export-only .The tigers' growth relied disproportionately on external demand. During 1950-70, the world economy expanded and US demand, especially for goods related to its military campaigns in Asia, was strong. For China, domestic consumption has fuelled much growth, at least in urban areas. Going forward, growth potential is as much internal as external.

'New' endowments .In the tigers, a tremendous amount of human capital -- education and business and technical experience -- was accumulated in the process of growth. When factor accumulation slowed in the 1990s, and the inefficiencies of over-investment manifested in the regional financial crisis, a realignment of institutional incentives meant that countries such as South Korea could adapt and grow on the strength of the improved human capital endowment.